The Markets of Health: Part II

This post is the second part of a series on the health care and health insurance markets; the first post dealt with the characteristics of the health care market(s). This one addresses the health insurance market(s).

Whereas many pundits and politicians have attempted to claim health care “isn’t a market,” health insurance usually falls into the “shouldn’t be a market” category to them. Yet, much like health care, health insurance doesn’t cease to be a market (or series of markets) just because people don’t like them. Likewise, however, acknowledging or stating health insurance is a market does not preclude the possibility of market failure or desirability of government intervention to address said failures.

In the abstract, health insurance as a product or service is fairly simple – an insurer agrees to cover unexpected expenses, and the insured pays the insurer to accept that risk. Of course, that provides a conflict to the insurer between maximizing profit via minimizing claim payouts and the reputation damage to future revenue from doing so. However, it should be noted that health is hardly alone in having this insurer conflict: auto insurance, property and casualty insurance, and even life insurance have similar problems – none of them leading to demands that these insurance markets be nationalized (i.e., replaced with a government “single payer” monopoly). Of course, health insurance does have its own unique characteristics. To wit…

It’s far more likely to be used by the insured than most other insurance types. Indeed, it is likely that whole life insurance (as opposed to term) is the only type of insurance more likely to be used. As such, risks are a good deal higher than P&C, or even auto. Yet this isn’t even the biggest differences. Those two follow.

First, health insurers are also price negotiators with providers, in a way auto and P&C insurers never are. The market power health insurers have acquired (driven in part by the fact that the insured file claims far more often) have created a characteristic that is unique in insurance. However, that also shifts the relationship between insurer and insured, creating a service of which every insurer – and few if any insured – are aware.

This is in part due to the second major characteristic, most Americans still outsource insurance shopping to their employer. Due to the tax deduction for health insurance (offered by Congress to World War II employers as a way to address labor shortages without causing salary inflation), the kind of decision-making Americans would make about life, auto, and p&c insurers is nonexistent. While most Americans are aware of how this distorts the market, the hidden cost of these (reducing the reputation mechanism effect described above, disincentivizing transparency in insurance in general, etc.) are not discussed as much. Indeed, an insurance market where employers are the purchasers has atomized what might be a competitive market (stress, might) into an endless array of mini-monopolies – impacting both rates (upward) and service (downward).

None of this should come as any surprise to Americans, who have argued about health insurance policy in one form or another for over 25 years. However, the separation between insurer and insured – which now resembles the separation in payment between provider and customer – has led many to conflate health insurance and health care into one market, which it isn’t. Health care markets are how people select services needed to improve their health. Health insurance markets are how people hedge against the financial risks of needing to use health care markets.

When it comes to addressing the failures of the health insurance markets, the first things that needs to be addressed (and removed), is the health insurance tax deduction. Its market atomization effects may not be immediately visible, but they do exist and need to be removed. Health insurers should have to compete for the entire marketplace in America, not lock in mini-monopolies with employers.

Without this difference, it should be easier to address the other issues regarding health insurance. Insurers will have an incentive to be more open not just about their rates and types of coverage, but the market power they can exert over providers in pricing. Governments can look to how p&c high-risk issues were and are addressed and use them in health care (for example, no private insurer will cover flood insurance, but the federal government does through the National Flood Insurance Program).

Finally, we should look at shifting how government intervenes in insurance markets: from provision based on income (current Medicaid) to provision based on risk (an analogy for the aforementioned NFIP). To an extent, the federal government does this already via Medicare – but Medicare is strictly age-based, which is an imperfect metric for risk (and was actually enacted based on affordability and income concerns, not concerns of risk). Reforming Medicare to a risk-based “insurer of last resort” (and expanding it as such to all ages) could both eliminate the need for Medicaid (whose effectiveness in health outcomes is patchy and uneven at best), while ensuring private insurance still survives as a competitive market and, if done correctly, decrease the heavy hand of government in health insurance.

To be clear, this would be neither the government-monopoly in health care and in health insurance desired by the left, nor the “free market” in either that many on the right espouse. However, it just might bring together the benefits of both while minimizing each one’s downsides and taking lessons learned from other insurance markets.